Tuesday, December 14, 2010
Fed's poor leadership leaves bond market open to speculative attack!
Back in November when the Fed announced its intention to unleash QE2, they said they would purchase an additional $600 bln of longer term securities. There was no mention of why or how they came up with that number. It almost seems completely arbitrary.
In reading the minutes of that meeting you could surmise that they had two reasons for the move. First, they thought they needed to take action to "promote a stronger pace of economic growth." But where were the guarantees that said buying an additional $600 bln in longer term maturities promoted stronger growth?
There were none.
The second reason given was that they wanted to keep the face value of the securities in their portfolio constant. Apparently they were worried that principal payments on existing agency and MBS securities would lower the overall amount of securities on their balance sheet. So what? Did they believe that would cause interest rates to rise? If they did, there was no explicit mention of that.
Nowhere in the minutes of that meeting was there any discussion of wanting to target a desired interest on longer-term maturities. NOWHERE! It never came up. Instead, the committee members just pulled some seemingly arbitrary number out of a hat--$600 bln--and assumed that's all they needed to do. Pardon my generalization, but it had all the look and feel of throwing something up on a wall and hoping that sticks.
Truth be told, if the FOMC had simply said that it wanted 10-year Treasury yields to be at 2% and that the Fed was going to buy those maturities until it reached that desired interest target, then that's what they would have gotten, with probably far less than $600 billion.
However, by focusing on quantity ($600 bln) instead of price (say, 2%), they left the bond market wide open to speculation. That's what's going on now, speculation. Thnk about it...10-yr Treasury note futures trade a notional amount of about $80 bln per day! Multiply that times 30 days in a month and that's $2.4T notional! That's 30 times more than the $75 bln per month the Fed said it was going to buy. Speculators can easily push bond prices down and yields up in response to the Fed's tepid and ill-thought-out buying program. That's exactly what they are doing.
It's an astonishing thing to say, but the people on the Board of Governors totally lack an understanding of the one thing that the Fed has absolute control over--interest rates. This is truly mindboggling. The members of the FOMC have left the bond market open to speculative attack as a result of their ignorance. And to make matters worse, there will be plenty of negative fallout from this because the commentary that will swirl about--people will be saying that inflation is surging, that the Chinese are selling our debt, that the national debt is skyrocketing, that the dollar is the cause, etc--will completely distort the truth and make policy more ineffective than ever. That means the outcomes will be even more disruptive. The FOMC has 12 members. None of them understood this???? Sadly, that's a correct statement.